Tesla-SolarCity merger could be fraught with danger -- and big potential

On the surface, a merger between Tesla Motors and SolarCity looks like a winner: They have a similar customer base, use each other's manufacturing facilities and technologies -- and of course, there's the family ties.

Tesla founder and CEO Elon Musk is also the co-founder and chairman of SolarCity, which is run by fellow co-founder and CEO Lyndon Rive and his brother, CTO Peter Rive -- both of them Musk's cousins. Musk owns 22% of SolarCity's stock and 21% of Tesla.

"In my personal opinion, this is obviously something that should happen. It's a no-brainer," Musk said during a conference call last week on the proposed merger.

"Instead of making three trips to a house to put in a car charger and solar panels and battery pack, you can integrate that into a single visit," Musk continued. "It's an obvious thing to do."

MJ Shiao, director of solar research at GTM Research, said he shares Tesla's vision that a comprehensive and integrated energy solution "will be necessary for consumers to control their own energy destiny in the wake of changing electricity rate structures across the country.

"However, it's unclear whether a merger is necessary for Tesla and SolarCity to build and brand these products together," Shiao added.

Industry experts say the plans by Tesla to buy SolarCity in a $2.7 billion all-stock deal announced last week aren't likely to work out for several reasons -- including similarities between the companies.

Raj Prabhu, CEO Mercom Capital Group, a clean tech research and communications firm, said he's skeptical of the merger because the ties between the two companies will likely create conflicts of interest.

"Both companies have the same majority shareholder, both are run by family members and their board members have ties to both companies. All of which can create serious governance issues, even with family members recusing themselves from the vote," Prabhu said.

Musk and Antonio Gracias, who serve on the boards of both companies, have said they will recuse themselves when SolarCity's board takes up a merger vote. Peter Rive also said he would abstain from SolarCity's merger deliberations.

SolarCity

SolarCity workers install a photovoltaic rooftop system.

Beyond the fact that Tesla's "Gigafactory" in Nevada will produce lithium-ion batteries for both its electric cars and for SolarCity to sell to customers for home and business use, some have speculated that Tesla's retail stores could be used to sell solar installations combined with the finance lease and loan expertise of SolarCity.

Last year alone, Tesla received a significant amount of revenue from selling lithium-ion battery systems to SolarCity; in fact, it amounted to 36% of all behind-the-meter battery revenue, according to GTM Research.

However, selling rooftop solar from a Tesla retail store will not be easy, Prabhu said.

"They are still very different businesses and a slump in one business will be a drag on the whole company and become a distraction," Prabhu said. "The biggest pain point will be the debt that Tesla would take on. If this deal goes through, it would more than double Tesla's debt, which could scare investors away. In the end, it all comes down to the shareholders and they have not reacted to the deal positively so far."

Both Tesla and SolarCity are incurring massive amounts of debt because the companies are spending in order to expand in what are still fairly niche industries.

Sunrun

A Tesla Powerwall battery system as installed by Sunrun. The batteries can be installed inside or outside of a home.

While neither company is yet profitable (Musk has said Tesla will be profitable by 2020 when it's selling 500,000 cars a year), SolarCity has about $6.24 billion in liabilities, including its debt. According to Bloomberg, Tesla's debt has mushroomed 13-fold in the past three years to $3.25 billion.

"If Musk wasn't a majority shareholder in both the companies, there would be very little chance for a deal like this to go through," Prabhu said.

Tesla shares tumbled more than 10% after the all-electric carmaker announced the planned takeover. Conversely, SolarCity's stock, which has been steadily dropping over the past two years, experienced a modest uptick on the announcement.

SolarCity could hurt Tesla in light of the fact that neither company is yet profitable and SolarCity is struggling financially, said Tyler Ogden an analyst with Lux Research.

"I think it's far from being a done deal given the current state of both companies, neither making a profit and pretty clear expansion plans on the line," Ogden said.

SolarCity, Ogden said, has a different business model than Tesla and needs to take on more debt in order to fund the manufacturing and installation of solar systems that are mainly purchased by customers through leases or power purchase agreements (PPAs).

"Part of the business model is acquiring a lot of debt to fund its pipeline upfront," Ogden said.

Ogden also pointed to the recent bankruptcy filing by the world's largest solar energy developer, Sun Edison, as a cautionary tale. Sun Edison had assumed more than $12 billion in debt as it expanded and acquired other providers in the process.

SunEdison, a pioneering manufacturer of silicon wafers and the world's leading renewable energy developer, was once the fastest growing company in the renewable energy market.

SolarCity, however, has nowhere near the debt Sun Edison has and it has some lucrative utility deals in the pipeline that will significantly increase its revenues; one project is even tied to Tesla.

Kauai Island Utility Cooperative

This 12 megawatt Koloa solar array owned by Kauai Island Utility Cooperative was built by SolarCity and went into operation in 2014. SolarCity plans to build a larger array at Kapaia with a unique battery energy storage system.

SolarCity won a 20-year contract to build and run a 52 megawatt (mW) first-of-its-kind solar array and energy storage system on 50 acres for Hawaii's Kaua'i Island Utility Cooperative (KIUC). Tesla will supply the batteries that will provide 13mW worth capacity. The solar array is expected to go live by the end of 2016.

KIUC will purchase energy for 14.5 cents/kWh through a 20-year power purchase agreement.

"SolarCity still has the potential to hurt Tesla. We've already seen how the market responded to the acquisition with Tesla's stocks going down given the huge debt load of SolarCity -- there's always the possibility of bankruptcy," Ogden said. "But, given the way SolarCity is moving, I don't see [SolarCity] following a similar path of Sun Edison, largely because of its vertical integration strategy."

SolarCity, for example, has been acquiring companies, such as Zep Solar, in order to be able to supply all of its own rooftop mounting equipment. And, it is now building its own high-efficiency solar modules, which allows it to control the price of production.

"The combination of those things will make it a key competitor in the residential and commercial space, particularly from a lower-cost perspective," Ogden said.

“One benefit that this acquisition could have,” he continued, “is to create an integrated alternative energy company before any of its potential competitors gain a foot hold in the market.”

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